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Review Questions 8F11.pdf

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Department
Administrative Studies
Course
ADMS 3530
Professor
Lois King
Semester
Summer

Description
Review Questions 8 Textbook Page Questions 295 2 296 8, 10, 13 297 16, 18, 19, 22 298 24 Solutions 2. a. Average cost = $1.75 million / 1 million = $1.75/burger b. Average cost = $2.25 million / 2 million = $1.125/burger c. The fixed costs are spread across more burgers — thus the average cost falls. 8. At the break-even level of sales, which is 60,000 units, profit would be zero: Profit = 60,000  (2 – variable cost per unit) – 20,000 – 10,000 = 0 Solve to find that variable cost per unit = $1.50 10. a. Accounting break-even would increase because the depreciation charge will be higher. b. NPV break-even would decrease because the present value of the depreciation tax shield will be higher when all depreciation charges can be taken in the first five years. 13. If CF = 0 for the entire life of the project, then the PV of cash flows = 0, and project NPV will be negative in the amount of the required investment. 16. Figures in Thousands of Dollars Sales $16,000  Variable cost 12,800 (80% of sales)  Fixed cost 2,000  Depreciation 500 (includes depreciation on new checkout equipment) = Pretax profit 700  Taxes (at 40%) 280 = Profit after tax $ 420 + Depreciation 500 = Cash flow $ 920 a. Cash flow increases by $140,000 from $780,000 (see Table 8.1) to $920,000. The cost of the investment is $600,000. Therefore, NPV = –600 + 140  annuity factor (8%, 12 years) = –600 + 140  7.536 = $455.04 thousand = $455,040 b. The equipment reduces variable costs from 81.25% of sales to 80% of sales. Pretax savings are therefore 0.0125  sales. On the other hand, depreciation charges increase by $600,000/12 = $50,000 per year. Therefore, accounting profits are unaffected if sales equal $50,000/.0125 = $4,000,000. c. The project reduces variable costs from 81.25% of sales to 80% of sales. Pretax savings are therefore .0125  Sales. Depreciation increases by $50,000 per year. Therefore, after-tax cash flow increases by (1 – T)  (Revenue –  Expenses) + T  (Depreciation) = (1 – .4)  (.0125  Sales) + .4  50,000 = .0075  sales + 20,000 For NPV to equal zero, the increment to cash flow times the 12-year annuity factor must equal the initial investment. cash flow  7.536 = 600,000 cash flow = $79,618 Therefore, .0075  Sales + 20,000 = 79,618 Sales = $7,949,067 NPV break-even is nearly double accounting break-e
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